Point out and explain how corporations today are adopting good corporate governance practice in order to address principal-agent conflict (agency theory) in order to reduce the agency cost.

The notion of agency is used to better comprehend the interactions that exist between agents and principals. In a given business transaction, the agent represents the principal, and he or she is required to operate in the principal's best interests at all times, regardless of his or her own personal interests. Because certain agents may not always behave in the best interests of the principal, the divergent interests of principals and agents may become a subject of contention. It is possible that the subsequent miscommunication and disagreement will cause a variety of problems and strife within organizations. Incompatible aspirations can force a wedge between each stakeholder, resulting in inefficiencies and financial losses for all parties involved in the transaction. As a result, the principal-agent issue is created.

Step-by-step explanation

Changing the norms under which the agent operates and restoring the interests of the principal are both possible through the application of corporate governance. By appointing an agent to represent the principal's interests, the principle must overcome a lack of knowledge regarding the agent's performance of the duty assigned to the agent. Agents must be provided with incentives that encourage them to act in accordance with the principal's best interests.  Because of this, agency theory may be utilized to properly design these incentives by taking into account what interests motivate the agent to act. In order to prevent moral hazard, it is necessary to remove the incentives that encourage bad behavior and to implement policies that discourage it. Understanding the mechanisms that cause problems might assist firms in developing more effective corporate policies and procedures.

How to solve principal-agent conflict

Appropriate incentives

The first technique for solving the principal-agent dilemma is to look at the agent's incentive structure. The motive offered to the principals is the source of the principal agent dilemma. According to the principle agent problem experiment, high agent performance was observed when good compensations were offered to the agents. Despite the fact that the link between compensation and performance is not linear, the agents' outputs have a positive association with their compensation. In the economic world, dynamic incentives are quite essential. Wages of managers and employees in a firm might have an impact on the company's performance results. Agents will be more motivated to do their best if their income is linked to their performance.

In a firm, compensation might be linked to employee performance. Managers' pay might be tied to company performance. This will motivate the company's managers to perform their best. The company's stockholders can also benefit from increased profits. An alternative idea is to offer the company's managers corporation stock. Stock prices affect managers' pay. Managers will be motivated to boost the company's stock price. This package is offered by several listed firms.  This is the simplest solution to the primary agent problem, with immediate results. The principle agent problem is best solved by awarding managers corporate shares that is linked to their performance. Giving managers equity may result in insider trading which is a problem to the company.

Transparency among both parties

When there is a mismatch in understanding between the agent and the principal, agency difficulties are most likely to occur. It is far too simple and enticing for the agent to take advantage of the knowledge gap for his or her own gain. When agent-principal connections form in your organization, full transparency can aid in closing the knowledge gap and preventing the emergence of the agency problem. The agent ought to be always disclose all information before making decisions on behalf of the principal. He/she should not hide any necessary detail for his/her self interest.

Restricting the agent

Giving the agent an excessive amount of authority to act on your behalf opens the door to future difficulties and may cause the financial advisor to make poor decisions in the future. Many of the world's most successful governments employ checks and balances because it helps to keep the power of any one people or entity in check and corruption to an absolute minimum.

Agent performance evaluation.

Another solution to the principal agent dilemma is to observe and assess the agents' actions. In a corporation, the managers are the agents and the principals are the stockholders. Stockholders regularly watch managers' actions to ensure they are acting in their best interests. The examination of the company's performance is also vital. When performance evaluation is used to determine employee compensation, there is still space for improvement. Managers tend to perform better when they are monitored.
Continuous performance evaluation can encourage management. The company's performance can improve due to constant inspiration. This is the strategy's main benefit. However, evaluating managers takes time and money. Agent evaluation or monitoring can be costly.